Level 1 CFA® Exam:
Analysis Framework for Financial Statements
Analysis Framework for Financial Statements - Intro for Level 1 CFA Candidatesstar content check off when done
In this lesson, we will talk about the analysis framework for financial statements. We will say how such a framework is designed and why it should be followed. We will also briefly describe the steps provided by the framework to make you realize the significance of every step both in isolation and in unison.
In their work, analysts perform many different types of analyses concerning various companies and industry branches. Despite of this diversity of tasks and responsibilities, there is one common analysis framework. It is to ensure that the process of analysis is coherent and consistent regardless of the conducted analysis, that is regardless of the purpose of the analysis, the company analyzed, the securities or investments under scrutiny, and so on. The framework provides a sequence of stages to be always covered when conducting an analysis.
Why is it beneficial to have a common analysis framework for financial statements?
In the general perspective, it guarantees coherence in the field of analysis making and this is what we have already said. As far as more specific situations are concerned, on the other hand, it allows selecting the required information in an organized way. This is crucial because financial statements include a magnitude of various information and usually in a particular situation only some selected information is needed, and not the whole of it. If the required information is obtained in an organized way, the analysis process is less susceptible to error.
So, what is the recommended analysis process? The common analysis framework for financial statements gives the following sequence:
- State the purpose of the analysis.
- Gather input data.
- Process data.
- Interpret and analyze processed data.
- State findings and recommendations.
- Review findings periodically (follow-up).
As we can see, we should begin with stating the purpose of the analysis. Then, we have to gather the so-called input data. Later, the gathered data should be processed and interpreted. Finally, we are ready for stating our findings and recommendations. Last but not least, we should also remember to regularly check whether the results of the conducted analysis are still valid.
In your exam, you may be asked about the sources of information in a given stage or the outputs of the stage.
Bearing this in mind, let us now have a look at the six stages of the analysis framework one by one:
In the first stage of our analysis, we state the purpose of the analysis.
As we have already said, financial statements abound in various information and usually, we need only some selected pieces of information. When we define the purpose, we will be able to focus on the essence, instead of being lost in copious calculations.
To properly define the purpose of our analysis, we have to know the whole analysis context, for example, we have to know what the end product is going to be, who is the recipient, and whether these things are governed by some regulations.
The source of information for this stage will be determined by:
- the nature of the analyst’s task and responsibilities,
- the client’s or supervisor’s needs and expectations, and
- any norms, guidelines and the like developed to regulate the specific product of the analysis.
The output will include:
- defining the purpose, that is determining the goal or objective of analysis.
- wording specific questions to be answered by the analysis,
- some sort of schedule plus resources for carrying out the analysis.
The second step is gathering input data. As the name itself suggests, in this stage of analysis we collect data to be able to conduct our analysis. After all, it would be impossible to even initiate the whole analysis process without some input data.
Having collected data, we now have to process them. That’s what we do in the third stage of financial statements analysis. The processing of data requires the use of appropriate tools, which makes the analysis possible.
The source of information here is of course:
- the data from the previous phase.
Since the data that we collected may have different formats (for example the analyzed companies may use different accounting standards for creating their financial statements), we often have to adjust the collected data to make them comparable.
Thus, the output for this stage includes:
- adjusted financial statements,
- common-size financial statements,
- any needed calculations, such as ratios or rates,
- graphs and charts of any form, and finally
The fourth stage consists in interpreting the collected and then processed data.
Now that we have come to our conclusions, we may proceed to the fifth stage, namely, we may finally state our findings and recommendations.
The source of information includes:
- the obtained analytical results,
- guidelines and regulations for publishing reports.
What you need to pay attention to as far as stating findings and recommendations is concerned is the fact that depending on the nature of the analysis and your role in achieving its outcome, the guidelines and regulations governing your findings and recommendations may vary.
Note that also the Code of Ethics and Standards of Professional Conduct regulate how such a recommendation should look like. You will find more about this in our lesson on Standard V (B).
The output at this stage includes:
- a report answering the earlier posed questions,
- the recommendation relating to the previously defined purpose of analysis.
The last stage, that is the sixth stage, of analysis is the periodic review of the findings.
Level 1 CFA Exam Takeaways: Analysis Framework for Financial Statementsstar content check off when done
- One common analysis framework is given to ensure that the process of analysis is coherent and consistent regardless of the conducted analysis.
- The common analysis framework for financial statements gives the following sequence: (1) State the purpose of analysis. (2) Gather input data. (3) Process data. (4) Interpret and analyze processed data. (5) State findings and recommendations. (6) Review findings periodically (follow-up).